Fed Gives Breathing Room to Asian Economies

The U.S. Federal Reserve’s surprise decision not to pull back on a $85 billion monthly bond-buying program provides some respite to Asian economies that have been under pressure due to concerns about an end to U.S. easy-money policies.

Reuters

A trader watches U.S. Federal Reserve Board Chairman Ben Bernanke’s news conference on the floor of the NYSE.

Barclays Capital, in a note, points out that Asian countries with large current account deficits – notably India and Indonesia – could see the most short-term benefit to their currencies, bonds and stocks from the Fed’s decision to leave its extraordinary monetary policies in place.

Both these nations have faced massive selling of their currencies and have had to offer investors much higher rates to borrow money since the Fed intimated in late May it would soon begin winding down its bond buying.

That’s because investors, anticipating higher U.S. rates, began to reduce their exposure to more-risky emerging markets. India and Indonesia – along with Brazil and Turkey – were especially vulnerable because they import more than they export, making them reliant on foreign capital inflows to fund the deficit.

The Fed’s latest actions “may foster expectations that capital outflows from EM can stop or even reverse,” Barclays said. “This should be particularly supportive for the currencies and rates markets of countries with higher current account deficits.”

Both India and Indonesia have tightened monetary policy in recent weeks in an attempt to stop the outflows. Investors may now start to think more monetary tightening – which risked further squeezing economic growth – may not be necessary.

“Some of the priced-in expectations of aggressive monetary tightening may be unwound,” Barclays said.

U.S. Treasurys rallied on the Fed news, pushing down yields, giving emerging markets some breathing room. Gold spot prices traded in New York jumped 4% on the news. The U.S. dollar lost ground against major currencies.

Asian markets rallied Thursday. Malaysia’s ringgit rose 2%, the Indonesian rupiah was 1.7% higher, and the Thai baht up 2.1% – but still way down from their levels at the start of 2013.

Indonesia’s 10-year government bond was yielding 7.90% down from 8.16% before the Fed’s decision. That’s much lower than yields of almost 9% earlier this month, and makes it easier for the country to fund a large budget deficit.

The Indian rupee was at 61.84 to the U.S. dollar, a five-week high, and much stronger than a record low of over 68 late last month.

“The biggest beneficiaries will be Asian currencies,” said Credit Agricole. “While the Fed has merely delayed tapering this will not stop markets from following through on the positive dynamic today. The positive tone will be reinforced across Asian and European markets.”

But there’s a downside, too. Some observers said the Fed’s surprise move – a result of concern that a recovery in U.S. jobs is not as strong as some would like – will take the pressure off Asian economies to institute much-needed reforms to their economies.

India and Indonesia were punished in the recent sell-off as they failed to use the massive inflows of capital following the 2008 global recession to make their economies more efficient and bring budget deficits under control. Much of the inflows went on consumption, exacerbating trade deficits.

Others said the Fed – also spooked by a massive sell-off in emerging markets since the summer – has only delayed a reduction in its bond-buying until later this year.

“The market got a huge sugar rush,” said Kit Juckes of Societe Generale. “On the downside we are going to have to do it all over again soon. The sooner taper starts the sooner the world can move on.”

Barclays says it now expects the Fed to reduce its bond buying in December, at which time Asian economies could feel the pain all over again if they don’t take steps to cut debt and open their economies to more investment.

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